Spectrum FX Daily Market Update
Latin American currencies join US dollar in strong rebound
Last week we saw an unusual combination of winners.
The US dollar bounced back, perhaps unsurprisingly given the stretched short dollar positioning in markets, yet another positive surprise from the US labour market, and the general correction of recent trends in financial markets. Unusually, however, key Latin American currencies managed to buck the usual correlations and actually rose against the greenback. The Brazilian real and the Mexican peso both finished at the top of the weekly performance rankings. Signs that the pandemic may be peaking in both those countries deserve some of the credit, undoubtedly, but also the fact that both those currencies had suffered the worst pandemic losses of all the majors and were undoubtedly cheap.
The key for trading this week will be the ECB September meeting on Thursday. Markets will be eager to see the central bank's reaction to the latest economic numbers, especially the inflation shocker that saw core inflation drop to an all-time low of 0.4% year-on-year. We think that the combination of Euro Area inflation weakness, US labour market strength and extreme long euro positioning is likely to result in temporary weakness in the common currency.
GBP
Sterling seems to be caught between two opposing trends. On the one hand, economic data in the UK has been surprising to the upside. On the other, there seems to be no progress in the Brexit negotiations so far. Our expectation is for economic data to start taking a back seat to Brexit negotiations over the next few weeks.
Given how fast the Pound has risen since the pandemic lows and the tendency to take Brexit negotiations down to the wire, this could mean recent short-term weakness in Sterling continues. PM Johnson has reportedly set a 15th October deadline for an agreement to be reached, so expect some volatility in the markets as this date draws near.
EUR
Alarms must have gone off at the ECB's Frankfurt headquarters last week. A shocking inflation report showed the key core inflation measure come in vastly under expectations at 0.4%, its lowest point ever. The euro then breached the psychological level of 1.20 to the dollar at one point, though it fell back later in the week.
We'd wager that neither development had been expected by the ECB at its previous meeting. While we do not expect any immediate change in monetary policy, this week's meeting takes on added importance for FX traders. It will be key to see how much tolerance there is in Frankfurt for further currency appreciation in the context of near zero inflation.
USD
US economic data was fairly strong last week. The ISM indices of business activity are all in solidly expansionary territory, above 56 for both services and manufacturing. Critically, the labour market report for August confirmed the positive news from the weekly jobless numbers. A net 1.4 million jobs were recovered in August. Even more positive was the household report on unemployment, pegging the unemployment rate at 8.4%, far below expectations.
This week, with little in the way of news beyond Friday's inflation numbers, we expect the dollar to react primarily to news from the ECB meeting as well as any headlines from the negotiations between Democrats and Republicans on the size and composition of additional stimulus measures.
CHF
After falling to its lowest level against the euro since June last week, the franc regained a portion of its losses and continues to trade around the 1.08 mark.
Macroeconomic readings from Switzerland released in the past few days have continued to point towards improvements in the economic landscape in Q3. Stubbornly low inflation deep in negative territory does, however, cloud this largely positive picture. Consumer prices fell 0.9% in August from the year prior, showing the same dynamics as in the previous month. This does not, however, mean that deeper negative rates are necessarily on the horizon. Recent communications from SNB president Jordan suggest that FX intervention remains the the bank's preferred tool, rather than additional interest rate cuts.
Wednesday’s unemployment data will be the only key data point out this week. This is expected to show a further, albeit limited deterioration in the Swiss labour market. The franc will, however, likely continue reacting mostly to outside news.
AUD
The Reserve Bank of Australia kept interest rates on hold at record lows last week. With no change in policy expected going into the meeting, investors were instead looking out for comments in the accompanying communications regarding the state of the domestic economic recovery. Governor Lowe stated that the recovery would be uneven and bumpy, warning about the impact of the prolonged lockdown measures in the state of Victoria. He did, however, state that the downturn had not been as bad as first feared and that the recovery was under way across most of Australia. This upbeat tone makes us more confident in our view that the RBA will no entertain the idea of cutting rates below zero any time soon.
Meanwhile, the Q2 GDP data surprised to the downside last week. The Australian economy contracted by a greater-than-expected 7% QoQ versus the 6% contraction priced in. The lack of timeliness in the data ensured that investors largely overlooked its release, with the sell-off in AUD largely driven by the broadly stronger US dollar. This week is quiet in terms of domestic news, so we expect the Aussie dollar to trade mostly off external developments.
CAD
Friday’s Canadian labour report came in mostly in line with expectations, with a net 246,000 jobs created in August. This was, however, slightly below consensus, as was the unemployment rate, which fell to 10.2% after investors had eyed a decrease in the measure to 10.1%. Investors chose to largely overlook the data, with CAD ending the week more-or-less unchanged versus the US dollar, making it the best performing currency in the G10. This outperformance is fairly astonishing given that global brent crude oil prices ended the week almost 9% lower - a development that would ordinarily feed its way through to a weaker CAD.
We now look ahead to Wednesday's interest rate decision from the Bank of Canada. With rates almost certain to be kept unchanged, we will be paying close attention to the accompanying press conference from governor Tiff Macklem as he addresses the bank’s view on the state of the economic recovery. Should he again emphasise the need for a prolonged period of accommodation, or even hint that an increase in stimulus could be on the way soon, then CAD could come under a bit of selling pressure this week.
CNY
A strong set of domestic economic data proved enough to allow the Chinese yuan to end last week modestly higher versus the broadly stronger US dollar.
Last week’s macroeconomic news out of China was encouraging, providing further evidence that Asia’s largest economy was bouncing back well following the COVID-induced lockdowns. Early in the week, the August PMIs from Caixin and Markit all overshot expectations. Arguably the most encouraging is the big positive surprise in the services index from Caixin, which came in at a very healthy 54.0 last month versus the 50.4 that investors had pencilled in. This morning’s trade data for August also surprised to the upside, suggesting that both domestic and worldwide demand was holding up well despite the virus uncertainty. Exports jumped by 9.5% year-on-year in US dollar terms (11.6% in CNY), its third consecutive month of increases.
This week should be a slightly quieter one in China, with the latest inflation data on Wednesday the only economic data release on tap. We expect CNY to instead be driven largely by any headlines out of US-China trade discussions.